Description

MTR Gaming (“MTR”) is a gaming company centered around one main asset, the Mountaineer Race Track and Gaming Resort (“Mountaineer”). In addition, MTR owns a number of other horse race tracks, licenses to build tracks, and a Las Vegas Casino. One of these licenses to build is located in Erie, PA and is to receive one of the 7 coveted gaming licenses being issued to horse tracks in PA. The other MTR racetracks are in locations that are contemplating favorable gaming legislation.

I believe that MTR is cheap given the current valuation on its Mountaineer facility and the license to build in Erie. In addition, there are numerous value-enhancing opportunities MTR has, which are discussed below.

Mountaineer:

Located in Chester, West Virginia, this track has been operating as a racetrack casino (“racino”) for more than 10 years. The four tracks in West Virginia were the first racetracks in the US to add slots to their racing facilities. These facilities have become the model for proposed “racino” legislation in a number of other states.

The Mountaineer facility sits atop 2,700 acres of land (2,200 unused) 50 miles west of Pittsburgh. It currently operates 3,220 slot machines, a hotel, golf course, conference center, and racetrack. The 3,220 slots are more than any Las Vegas casino. This facility will generate approximately $280mm in revenues and $50mm in EBITDA for 2004. Growth has slowed to single digits at this facility, but management feels that they can use the 2,200 acres of unused land to attract new gamblers by building a mall, residential homes and other entertainment venues. In addition, West Virginia may allow table games at these facilities to compensate for the new competition in Pennsylvania. After speaking to a number of West Virginia delegates and senators, it is our belief that the legislators will put forth a referendum for table games by July 2005.

Impending Pennsylvania racino competition will likely hurt Mountaineer. The facility currently competes with Wheeling Downs for Pittsburgh customers and currently derives about 20% of its customer base from Pennsylvania, with the rest from Ohio and West Virginia. Given the location of Wheeling, Mountaineer stands to lose about 6% of its revenue base (according to management). This assumption appears reasonable assuming that the new facilities take a 30% market share in Pittsburgh. This implies a reduction in EBITDA of $5mm in 2006 (when PA comes online). Approval of table games in West Virginia should mitigate the potential EBITDA reduction, if not completely offset it.

Pennsylvania:

The new Presque Isle Downs facility is to be located in Erie, PA (“Presque”). This facility currently has a racing license and will receive a gaming license as a result of the current legislation. To build the facility, MTR will have to make a $50mm license fee payment, and spend an additional $60mm to $80mm to build the actual track. This will be done in phases, as MTR will be allowed to operate a temporary facility. The local governments have offered MTR a subsidy to build the facility, worth approximately $48mm. In PA, the facility would be allowed to operate 3000 slots on day one, and add an additional 2000 slots 6 months later; however, management intends to only add about 2000 for the opening. The facility is to be located about 100 miles from the nearest competition.

Management believes that this facility can do approximately $30mm in EBITDA three years after the open in early 2006. For purposes of our valuation I have used $30mm in EBITDA. This assumes that the facility will start with 2000 slots, growing at 7% per year, similar to the growth at a similar stage at the Mountaineer facility. For the year of opening, I assume a win/unit/day of $160, growing at 4% per year. The win/unit/day is comparable to Mountaineer ($234 for the latest quarter), given the relatively remote location of the facility. Management stated that they assume the facility will do approximately $150 to $175 w/u/d upon opening.

Value of existing facilities – Using a DCF valuation and a 12% discount rate, the existing facilities are worth about $12/share. This assumes that Mountaineer maintains $45mm of EBITDA (after PA opens), growing in the low single digits each year. For PA, I assume that the facility can generate $30mm of EBITDA after 3 years. The value includes the $50mm license fee that MTR has to pay, and the cost of the $70mm facility – this is partially offset by a subsidy the company expects to receive. Finally, I have added approximately $7mm in EBITDA for Binion’s Casino in Las Vegas. This puts the total value of MTR at approximately $345mm. This is conservative when compared to the Pennsylvania facility that Penn Gaming sold to Mohegan Sun for $280mm in October of this year. The Penn Gaming track is located in the Pocono’s, PA and according to MTR management, should be able to produce results similar to Presque. This $280mm purchase price does not include a $50mm license fee still to be paid, and a budgeted cost to build the facility of $175mm, valuing Penn’s property at $500mm.

Ohio:

The Company has a track in Ohio, just outside of Columbus (“Scioto Downs”). Ohio is now in a tough situation; with a number of citizens traveling across state lines to Michigan, PA, and West Virginia to gamble, the state is losing several hundred million, if not a billion, in potential revenue. MTR, as well as a number of other gaming companies in the area, are pushing the legislators to pass laws allowing the state’s horse tracks to establish racinos. Should such an event occur (management gives it a 60% chance of happening in 2005), MTR is in prime position to benefit. The facility will probably cost $75mm to upgrade for the purposes of gaming, and MTR will pay a proposed $16mm license fee. Assuming that this facility can operate at similar metrics as Mountaineer (according to management, it can), then it should be able to generate $45mm in EBITDA three years after opening. This would generate an incremental $3.50/share in value for MTR. However, because Ohio constitutes 70% of the gaming market for Mountaineer, I have assumed a 20% revenue hit to the West Virginia facility. This results in Ohio adding $0.80/share in value, after the Mountaineer revenue decline. Once again, this decline at Mountaineer is expected to be completely offset by the addition of table games at that facility.

Michigan:

The Company recently bought a racetrack in central Michigan for $2mm. Currently, the state is trying to expand its gaming legislation, but was dealt a setback during the election with a requirement that all new gaming licenses be approved by citizen votes. According to management, the Governor is going to fight the election result in court. If she loses, gaming will still go forward, however, it will be delayed pending a referendum. According to management, this will be resolved by the end of 2005.

This facility is in central MI, far from Detroit (and any competition). The market for this track is southwestern Michigan where no other competition is established. Should the facility come on line, it should produce EBITDA of $30mm to $40mm three years out, depending on the proposed tax rates. Using a DCF analysis, this facility will add approximately $3.50/share in value to the Company. This valuation assumes that the track can operate on similar metrics as Presque and includes a cost of $75mm to upgrade the facility.

Minnesota:

MTR has entered into a 50-50 joint venture to build the second horse track in Minnesota. The initial license application has failed, however, the horse racing commission felt that it did not follow proper procedure and is reviewing the application again. The license for this track will include a license to build a card room on the facility. This JV is expected to generate $7.5mm of EBITDA for MTR, with $7.5mm in initial costs. However, while this is an attractive venture, the real opportunity is in the form of a racino. If one ever gets built (management feels this is beyond the 2005 timeframe), the facility could generate $35mm to $40mm of EBITDA three years after opening. This would value MTR’s 50% ownership in the property at $2/share. This is after an initial cost to build of $75mm.

Pittsburgh:

Finally, MTR has entered into an agreement with the Pittsburgh Penguins to apply to build a slot parlor in downtown Pittsburgh. This would be the only slot parlor in the city, and would face competition from only one track. According to PA law, it would only able to own 33% of the proposed facility, and there are a number of people bidding for the right to build this parlor. Should they succeed, the facility could generate $90mm in EBITDA due to its prime location. MTR’s 33% portion of this venture would add approximately $4.00/share of value. This, however, is a long shot given the number of bidders, and the state of the Penguins finances. In addition, this would not become a reality until 2007 at the earliest.

Valuation:

Below, I have outlined the basics of the valuation:

Mountaineer, Presque and Binion’s $12.00
Ohio $ 3.50
Michigan $ 3.50
Minnesota $ 2.00
Pittsburgh Penguins $ 4.00
Competition at Mountaineer (OH & PA) ($2.70)
Table games at Mountaineer $3.40
Total Potential Equity Value $25.70

While this in itself is attractive, management openly concedes that they think MTR will not be public three years from now. While the DCF valuation above fairly values the business, private market value may be higher.

Risks:

Currently there are two legal actions pending in PA; one targets MTR’s Presque racing license, and one targets the PA gaming legislation as a whole. If the former were to succeed, and MTR were to eventually be stripped of its license, its stock would substantially decline. While this is a risk, we believe that it is remote. MTR has won at the commission level and the lower court level. Currently, the suit is pending to the Supreme Court of PA, which is not obligated to take up the case. It is our understanding that historically the Supreme Court has decided not to hear this type of case. This appeal to the Supreme Court is only to force the racing commission to reconsider its license to MTR, and not strip it of its license. We believe that it is unlikely that the racing commission would reverse itself.

If competition to Mountaineer from Pennsylvania, and eventually Ohio were to be greater than expected, MTR’s stock may suffer. Pennsylvania has guaranteed that MTR will not face in-state competition within 30 miles for 10 years. Mountaineer’s closest competitors (Magna Entertainment’s Meadows and Wheeling Downs) are approximately 50 miles away.

Additional legislation increasing the taxes charged on slots could hurt the company. A couple of years ago Illinois increased its highest marginal tax rate for casinos to 70% of revenues. The net result was an overall decline in aggregate tax revenue as operators backed away, proof that there is an effective upper bound on marginal tax rates. Currently, West Virginia is taxing its casino’s at 58% to 60% of revenues, leaving little room to increase. Pennsylvania has guaranteed no tax increases for 10 years.

Disclosure:

My firm currently owns shares in MTR. I do not intend to update this write-up and we may sell our shares at any time without notice.

Catalyst

Catalysts:

MTR has the following catalysts, with my assessment of the likelihood of each transpiring:

Opening of Presque – Very likely;
Ohio passing gaming – Very likely to occur by the end of 2005;
Minnesota granting a racing license to MTR – Likely to occur in 2005, however, slots unlikely until 2006 by the earliest;
Penguins JV win bidding for track – Unlikely to occur. Should it happen, this would hit in 2007 by the earliest;
Michigan allows racinos – Likely to occur by the end of 2005;
Buyout of the company – Likely to occur in the next three years.